Globalization: Rusting away

Can Canada's manufacturing sector survive in the global economy?

Autoworker Maureen Kempston Darkes tied her future to the right industry when she joined General Motors of Canada decades ago. She currently has more overtime than the average workaholic could ever want. That’s good news for her, but not Canada. In 2002, Kempston Darkes left this country to oversee the auto giant’s operations in Latin America, Africa and the Middle East, where the company made hundreds of millions of dollars last year.

In North America, where the First Lady of GM used to run the Canadian subsidiary, First World labour and legacy pension costs add thousands of dollars to each vehicle the company produces. That’s why GM North America lost US$2 billion last year despite outselling all of its competitors, including Toyota. It’s also why vehicle assembly operations are shrinking, especially in Canada, which is now the most expensive place on the planet for GM to operate.

The world’s largest automaker isn’t the only manufacturer spinning its wheels. Ford and Chrysler have also been shuttering Canadian plants. And their suppliers are on even shakier ground. “The reality in our business is simple,” insisted Rob Wildeboer, chairman of Vaughan, Ont.–based auto-parts company Martinrea, while announcing plans in February to shut down a car frame operation in Kitchener, Ont. “A plant needs work to survive. A plant needs to be competitive to get work.”

Similar statements are being used to justify factory losses across Canada. Plant closures are nothing new. The average manufacturing facility in this country operates for less than a decade, according to Statistics Canada, and more than half stop production within six years (14% die in their first year and less than 20% remain operational after 15 years). But the closures have been escalating, and the numbers are not pretty, especially in central Canada, where manufacturing generates approximately 20% of the total economic output.

Since peaking in 2000, when the Canadian dollar was worth less than 65¢US, factory employment in Ontario and Quebec has annually declined by an average of 1.4% and 2%, respectively. The two provinces have lost more than 300,000 manufacturing jobs in the last half-decade — with urban areas around Toronto and Montreal taking about 50% of the hit.

The rapid rise in value of the Canadian currency to roughly par with the U.S. greenback is frequently blamed for manufacturing’s woes, but that’s a bit of a red herring. “The proposition that Canadian manufacturing strains are only the result of currency developments doesn’t stand up,” says Derek Burleton, director of economic studies at TD Bank Financial Group. In a recent report on Canada’s factory closures, he notes the United States has lost more factory jobs (on a trade-weighted basis) than Canada since 2000 — despite benefiting from a 24% drop in the U.S. dollar.

The real issue is globalization. After publishing a death notice last September for an 89-year-old turbine plant near Montreal, a GE Hydro spokesperson said: “This operation is not closing because of any kind of in-country situation. This is a global realignment of the entire business.” In Smiths Falls, Ont., where a Hershey Chocolate operation was a sweet employer for almost half a century, company management decided a year ago that more money could be made by moving to lower-cost Mexico.

Simply put, this nation is finally paying the global piper. Factory jobs started evaporating decades ago in the U.S., the United Kingdom and France, while Germany and Japan felt the pinch in the ’90s. Manufacturers in those nations adapted by improving productivity. Jobs were lost, but real output actually expanded. Thanks to exchange rates, however, Canadian manufacturers were able to enjoy the benefits of globalization (greater access to foreign markets), without being forced to improve operations like factories did in other developed nations. Now, Canadian plants face growing competition from low-cost regions and from meaner and leaner operations in developed nations. And they’re trying to adapt during an economic slowdown and global credit crunch, as well as with a stronger loonie.

Exporters think the Bank of Canada should somehow magically weaken the Canadian dollar. Labour unions — with more than a little support from industry executives — are crying for direct government aid. Buzz Hargrove, head of the Canadian Auto Workers union, even wants protectionist measures. The political response is finger pointing, especially in Ontario, where NDP leader Howard Hampton started the year waving around a Statistics Canada jobs report for December to show “tens of thousands of families across Ontario are losing their livelihoods and security every month.”

According to Hampton, the drop in jobs proves “Premier Dalton McGuinty has forgotten Ontario’s manufacturing heartland.” As he was criticizing McGuinty, though, the economy was confusing matters by creating more than 17,000 manufacturing jobs in central Canada. In January, Canada’s unemployment rate returned to a 33-year low of 5.8%. (The national unemployment rate was more than 12% in the early ’80s, which opposition parties said at the time was driving youths to kill themselves and forcing desperate mothers to water down baby formula.) But the relative health of the Canadian economy didn’t stop the McGuinty government from asking Ottawa to subsidize Ontario manufacturing.

Federal Finance Minister Jim Flaherty — who claims to be opposed to corporate handouts (at least directly, since the Harper government created a $1-billion community fund that companies may be able to tap) — pointed to a bare cupboard in February when delivering his budget. With a projected surplus of only $2.3 billion, Flaherty claimed he must conserve cash. He found money to restore a train route (shut down due to low ridership by the previous Tory government) that runs between Peterborough and Toronto, not to mention through his own riding. But while his political base got a railroad — which critics say could cost $150 million — Canada’s manufacturing sector was left feeling railroaded.

The budget did extend tax write-offs for equipment upgrades, but — as the Automotive Parts Manufacturers’ Association pointed out — that only helps profitable companies. The auto sector also got $250 million a year over five years to develop fuel-efficient vehicles. Ottawa, however, ignored pleas for hundreds of millions of dollars in emergency aid for failing companies. It didn’t even match the $30 million pledged by Queen’s Park to help reopen a Ford engine plant in Windsor, Ont.

Since then, the Bank of Canada has cut interest rates by 50 basis points. But the loonie is still flying high, because of factors the central bank doesn’t control. First of all, Canadian fiscal policy is in great shape, at least when compared to other G7 nations. Secondly, Canada is rich in commodities, and prices are boiling. Finally, like other national currencies, the external value of Canadian money has a lot to do with U.S. monetary policy.

Despite America’s official “strong dollar policy,” the U.S. Federal Reserve has been slashing interest rates, hoping to prop up the American economy and defrost the global credit meltdown. In mid-March, the value of the U.S. dollar dropped below 100 Japanese yen for the first time since 1995, while hitting all-time lows against the euro. The rate cuts are also one of the major reasons why the Canadian buck is still trading around par with the greenback.

Such parity is not a life-and-death concern for National Rubber Technologies, a tire recycler that employs a few hundred Canadians at two Toronto facilities. “We’re profitable with the Canadian dollar at par,” says president and CEO Greg Bavington. While other manufacturers are “taking on water and sailing with ripped sails,” his manufacturing company expects to survive and thrive even if “tougher weather hits.”

What’s National Rubber’s secret? Was the company a rare Canadian example of being proactive? “No,” says Bavington, the “financial failure of our previous corporate structure led to a CCAA restructuring that finished about a year ago.” As a result, the company now has a healthy balance sheet and U.S. operations. Company-wide, it is “extremely productive.” The timing of National Rubber’s descent into bankruptcy protection was quite fortunate. “It would have been much more of a challenge to restructure in this credit environment,” says Bavington.

As a manager, Bavington has plenty of sympathy for the politics involved in running a country with conflicting regional needs. He knows the Canadian economy as a whole has pretty much ignored the plant closures, which is why Ottawa sees no need to throw money at the problem. Nevertheless, he says, when manufacturers feel this much pain, the central Canadian economy typically tanks and the currency drops in value. That’s not happening this time, because of the unprecedented demand for oil and other resources. As Bavington points out, the bottom line is that Canadian manufacturers are pretty much being left on their own as they face a crippling combination of challenges.

Bavington admits new equipment can improve productivity, be it 10% or 20% or 30%. “That is simple arithmetic,” he says. “But manufacturing companies don’t have biweekly capital purchase planning cycles.” Before benefiting from productivity improvements, companies must first raise capital for new equipment, decide where to deploy it, then install the upgrade. That takes time and is extremely challenging, especially with a strong dollar and high energy prices. “We’re talking about companies that cannot even service their debt,” says Bavington. “They’re not worrying about the price of equipment; they’re worried about their next bank payment.”

And don’t expect companies to protect investors by simply moving operations. “We are not stitching buttons onto trousers,” says Bavington, waving at his company’s rubber plant. “We’ve got pieces of equipment that weigh a million pounds. Some would occupy 40 large shipping containers when dismantled. It would cost dozens of times our EBITDA to move. Even if you take the coldest view of things, the arithmetic isn’t always there.”

Not everyone thinks the sky is falling. “I struggle to see a current crisis in the auto sector,” says industry analyst Dennis DesRosiers. In 2007, he notes, Canadian automakers produced 16.7% of the total vehicle output in North America. That’s the second-best share on record, and came during a year of declining sales. It also doesn’t count a Toyota plant that will soon come online in Woodstock, Ont. While the auto-parts sector shed jobs last year, assembly plant employment was actually up, not down (total industry employment dropped 3.4% to 135,000). Meanwhile, more than $3 billion was invested in new equipment. That’s down from about $3.5 billion a few years ago, but U.S. auto investments dropped from US$22 billion to roughly US$12 billion in the same period.

Canada still has a lot of positives to offer as a manufacturing base, according to DesRosiers, from its educational system and skilled workers to its infrastructure and access to the U.S. market. That’s why it is still “one of the few countries that produce more vehicles than they buy.”

Still, DesRosiers admits, trouble in the parts sector is accelerating, and nobody expects a flood of new assembly operations. “Absolutely every vehicle plant in Canada has had the heavy hand of government influencing its location since we signed the auto pact in 1965,” he says. And that isn’t happening anymore. DesRosiers thinks the CAW should help itself by tearing the “featherbedding” from labour contracts and agreeing to two-tier wages, just like their brothers and sisters down south in the United Auto Workers union did last year. Hargrove, of course, says a two-tier system is “one automotive import that won’t cross the border into Canada.”

And that, perhaps, is why — when asked about the future of Canadian manufacturing — the first economist approached for this story simply said, “What future?”

On the record, economists are not much more positive. According to TD’s Burleton, Ontario and Quebec would experience further factory job losses of 250,000 and 100,000, respectively, if manufacturing’s share of total employment in central Canada simply matches those of other developed nations. And that forecast factors in productivity gains that require the capital investments Bavington says look almost impossible under current market conditions.